Does Cochrane Really Understand the Latest on Minimum Wages?

Does Cochrane Really Understand the Latest on Minimum Wages?

John Cochrane thinks we liberals who think higher minimum wages can do some good by offsetting monopsony power fail to grasp labor economics. He is citing some work by Jeffrey Clemens, Lisa B. Kahn, and Jonathan Meer. Alas his blog post screwed up the link to this interesting paper:

Compensation consists of a combination of cash and non-cash attributes, and depends on worker productivity. We also allow for the possibility of a bargaining wedge whereby the firm pays less in total compensation (cash and non-cash benefits) than a worker’s marginal product. When the minimum wage rises above the prevailing wage (cash payment) but below a worker’s marginal product, the firm will shift the mix of compensation towards cash and away from non-cash benefits, but will still find it worthwhile to employ the worker. This distortion can create losses to worker welfare which, if large enough, will push workers to prefer their outside option of nonwork. We also show that, in the presence of a bargaining wedge, the welfare effects of minimum wage increases are non-monotonic. In general, wage gains associated with increases in worker bargaining power will tend to improve welfare, while wage gains that are accommodated through reductions in non-cash benefits can reduce welfare.

In many ways, this dates to a 1980 paper by Walter Wessels (“The effect of minimum wages in the presence of fringe benefits: An expanded model,” Economic Inquiry), which the authors cite. Wessels assumed a perfectly competitive model where government interference lowered worker total compensation. Wessels published later papers, which alas the authors did not cite. In 1994, the Journal of Labor Research presented an extension of Wessels thinking that incorporated monopsony power entitled “Minimum wages and the wessels effect in a monopsony model” by J. Harold McClure:

The Wessels model suggests that firms respond to increases in the minimum wage rate by decreasing the level of fringe benefits — an action which produces an inefficiency effect that lowers workers’ utility and the supply of labor. Standard models of monopsony, however, argue that wage floors prevent the exercise of market power and increase employment. I show that wage floors, even with fringe benefit curtailment, may increase employment by lowering the marginal expense of labor. Employee utility and employment will rise somewhat but not as much had the firm acted competitively in setting both wages and fringes.

The “worker bargaining power” bit may be alluding to this monopsony power argument even if the authors did not cite this 1994 paper. The authors did note:

When we compare wage changes to changes in employer coverage, we find that coverage declines offset a modest fraction of wage gains for very low wage workers and a larger fraction for moderately higher wage workers. In very low paying occupations, the coverage decline offsets an average of roughly 10% of the rise in the wage bill. We cannot reliably measure changes in employer contributions on the intensive margin, which may also decrease in response to increases in the minimum wage. Therefore, the 10% average offset is composed of some workers who lose coverage entirely and some workers who maintain coverage and receive wage gains. We find offsets of 25% and 60% for workers in the next lowest paying occupation groups, respectively.

If I’m reading this correctly, total compensation rises even if fringe benefits decline – which is more consistent with the monopsony version of the Wessel model than the perfectly competitive version. Of course this is not the message that Cochrane has conveyed to the readers of his blog.